President’s Day in the U.S today, so markets are likely to be less liquid than normal. Besides that, it is extremely light on macro data, so there isn’t much to get our teeth into. I mentioned recently that the S&P 500 had been stuck in a range since the end of last year, but price action in the last week has quite decisively taken us through the top to new year to date highs, and indeed at the end of last week we saw new record highs posted. A quite remarkable performance all things considered, particularly as the technicals underpinning stocks look increasingly precarious at the moment. Since the crisis of 2007 – 08, earnings growth has tended to exceed revenue growth, which is not surprising in an environment with weak labour markets, basically it’s been easier to make money by cutting costs than by selling more goods. There are good reasons to bet on stocks (where else can you put your cash right now?) and then there are less good reasons. A world where sales are growing which then feeds into the bottom line is always the ideal, unfortunately we haven’t really had this for a long time (Apple and a few others being the exception). I mention all this because the US employment data at the start of February was so impressive. Labour markets in the United States appear strong and continue to tighten, we are already close to levels that the Federal Reserve would define as full employment. Even if there wasn’t a natural limit to efficiency gains it should still make one wonder. Sales growth simply has to start picking up soon otherwise it will be difficult to justify a continuing rise in company valuations. It is also hard to justify new capital investment without revenue growth. Please note that these observations have been focussed exclusively on the United States, the one truly bright star in a very cloudy macro-economic sky.
Currencies broadly reflect these issues, with the US dollar pre-eminent, but as we’ve mentioned several times in recent weeks, what we are seeing at the moment is less about the dollar and more to do with the specific problems other currencies have, being reflected in weakness against the greenback. The euro, and other European currencies continue to dance to the tune of debt renegotiations and extraordinary central bank actions to deal with a stagnating economic environment. We are still only at the start of a new paradigm where negative interest rates are not just a textbook possibility, but a reality that several markets are now experiencing. We are all out on a limb here, it’s difficult to truly comprehend the implications to investment decisions that negative rates will have. We will all have to learn on the hoof! Surely there’ll be unintended consequences that no one has properly considered yet?
For the moment stability of a sort has returned to financial markets, gold prices have fallen back sharply from the panic highs of mid-January, EUR/USD trades within a corrective complex that could still see the pair trade up to the 1.15 – 16 zone before the bigger picture trend reasserts and the bear trend continues. We still maintain that parity is a real possibility at some point, later on this year, but there’s many a slip twixt cup and lip.
For now, dollar strength remains easier to discern in select emerging market currencies, and the recovery in oil prices is enough to give hope that broader based recoveries are possible. We don’t share the positive recovery view, and even though we could see further strengthening in oil prices, we see this as a more technical happenstance. Demand characteristics will be a more important determinant for when energy prices really do stabilise, negative interest rates are a clear sign that that is not a world we live in at the moment.
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